Advancing a Free Society

From Fiscal Stimulus and Fiscal Anti-Stimulus

Monday, January 11, 2010

In an interesting new paper, University of Chicago economists Thorsten Drautzburg and Harald Uhlig calculate the impact the $787 billion fiscal stimulus package passed last year. Previous research, such as the paper by John Cogan, Tobias Cwik, Volker Wieland and me (CCTW), assumed that the higher taxes needed to pay interest on the increased debt caused by the bigger deficits were of the lump-sum variety with no distortions. Drautzburg and Uhlig more realistically assume that future marginal tax rates must rise. Because higher marginal tax rates reduce supply, they find that “the output loss in the medium-to-long term is substantially larger than in the lump-sum tax version” of CCTW. The results are illustrated in Figure 2 of the Drautzburg-Uhlig paper which shows that the longer-term losses outstrip any shorter-term gains very quickly. The paper is one of several technical papers presented at the conference "New Approaches to Fiscal Policy" at the Federal Reserve Bank of Atlanta last week.